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Interest Rate Models - Theory and Practice: With Smile, Inflation and Credit (Springer Finance) [Hardcover]

Damiano Brigo , Fabio Mercurio
4.5 out of 5 stars  See all reviews (2 customer reviews)
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Book Description

4 Aug 2006 3540221492 978-3540221494 2

The 2nd edition of this successful book has several new features. The calibration discussion of the basic LIBOR market model has been enriched considerably, with an analysis of the impact of the swaptions interpolation technique and of the exogenous instantaneous correlation on the calibration outputs. A discussion of historical estimation of the instantaneous correlation matrix and of rank reduction has been added, and a LIBOR-model consistent swaption-volatility interpolation technique has been introduced.

 

The old sections devoted to the smile issue in the LIBOR market model have been enlarged into a new chapter. New sections on local-volatility dynamics, and on stochastic volatility models have been added, with a thorough treatment of the recently developed uncertain-volatility approach.

Examples of calibrations to real market data are now considered.

 

The fast-growing interest for hybrid products has led to a new chapter. A special focus here is devoted to the pricing of inflation-linked derivatives.

 

The three final new chapters of this second edition are devoted to credit.

Since Credit Derivatives are increasingly fundamental, and since in the reduced-form modeling framework much of the technique involved is analogous to interest-rate modeling, Credit Derivatives -- mostly Credit Default Swaps (CDS), CDS Options and Constant Maturity CDS - are discussed, building on the basic short rate-models and market models introduced earlier for the default-free market. Counterparty risk in interest rate payoff valuation is also considered, motivated by the recent Basel II framework developments.


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Product details

  • Hardcover: 1042 pages
  • Publisher: Springer; 2 edition (4 Aug 2006)
  • Language: English
  • ISBN-10: 3540221492
  • ISBN-13: 978-3540221494
  • Product Dimensions: 4 x 16.7 x 24.2 cm
  • Average Customer Review: 4.5 out of 5 stars  See all reviews (2 customer reviews)
  • Amazon Bestsellers Rank: 187,963 in Books (See Top 100 in Books)
  • See Complete Table of Contents

More About the Author

Professor Damiano Brigo is Chair and co-Head of the Mathematical Finance research group at Imperial College, London, ranked 8th university in the world and 3d in Europe in 2012, after Oxford and Cambridge, by Times Higher Education. Formerly Gilbart Professor and head of group at King's College, Damiano was previously Managing Director and Global Head of the Quantitative team in Fitch Solutions.
Earlier on Damiano worked as Head of Credit Models in Banca IMI's front office and as Fixed Income Professor at Bocconi University.
Damiano published more than 70 works in top journals for Mathematical Finance, Systems Theory, Probability and Statistics, and field reference books in Interest Rates and Credit Modeling for Springer and Wiley.
Damiano is Managing Editor of the International Journal of Theoretical and Applied Finance, he has been a member of the Fitch Advisory Board and is part of Scientific committees for conferences occurring at MIT and other academic and industry institutions.
Damiano has been listed as the most cited author in Risk Magazine in 2006 and 2010 and has an H-index of 24 as of September 2012 (Google Scholar).
Damiano's interests include valuation and pricing, risk measurement, credit and default modeling, counterparty risk, collateral and funding, stochastic dynamical models for commodities and inflation, the interaction between the exponential statistical manifold and the dynamic features of stochastic processes laws, nonlinear stochastic filtering, and stochastic processes consistent with mixtures of distributions.
Damiano obtained a Ph.D. in stochastic filtering with differential geometry in 1996 from the Free University of Amsterdam, following a BSc in Mathematics with honors from the University of Padua.

Product Description

Review

From the reviews:

SHORT BOOK REVIEWS

"The text is no doubt my favorite on the subject of interest rate modeling. It perfectly combines mathematical depth, historical perspective and practical relevance. The fact that the authors combine a strong mathematical (finance) background with expert practice knowledge (they both work in a bank) contributes hugely to its format. I also admire the style of writing: at the same time concise and pedagogically fresh. The authors’ applied background allows for numerous comments on why certain models have (or have not) made it in practice. The theory is interwoven with detailed numerical examples…For those who have a sufficiently strong mathematical background, this book is a must."

From the reviews of the second edition:

"The book ‘Interest Rate Models – Theory and Practice’ provides a wide overview of interest rate modeling in mathematical depth. … The authors found a good approach to present a mathematically demanding area in a very clear, understandable way. The book will most likely become … one of the standard references in the area. … if one were to buy only one book about interest rate models, this would be it." (David Skovmand and Michael Verhofen, Financial Markets and Portfolio Management, Vol. 21 (1), 2007)

"This is the book on interest rate models and should proudly stand on the bookshelf of every quantitative finance practitioner and student involved with interest rate models. If you are looking for one reference on interest rate models then look no further as this text will provide you with excellent knowledge in theory and practice. … is simply a must for all. Especially, I would recommend this to students … . Overall, this is by far the best interest rate models book in the market." (Ita Cirovic Donev, MathDL, May, 2007)

"This is a very detailed course on interest rate models. Its main goal is to construct some kind of bridge between theory and practice in this field. From one side, the authors would like to help quantitative analysts and advanced traders handle interest-rate derivatives with a sound theoretical apparatus. … Advanced undergraduate students, graduate students and researchers should benefit from reading this book and seeing how some sophisticated mathematics can be used in concrete financial problems." (Yuliya S. Mishura, Zentralblatt MATH, Vol. 1109 (11), 2007)


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The concept of interest rate belongs to our every-day life and has entered our minds as something familiar we know how to deal with. Read the first page
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Customer Reviews

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Most Helpful Customer Reviews
4 of 5 people found the following review helpful
4.0 out of 5 stars Good book if you've got past Baxter and Rennie 14 Mar 2007
Format:Hardcover
This is a good overview of some of the more complex interest rate models, however it does assume familiatrity with the fundamental theorem of finance and hence why martingales are important. It assumes the reader knows all about filtration, probability spaces and changes of measure (Radon Nikodym derivatives and the change of measure theorem). If you are not already familiar with all this then the book will not be helpful to you - read something more basic like Financial Calculus (Baxter and Rennie).

Aside to the technical content, I find many of the quotes at the beginning of each chapter (usually from DC comics) pointless and sometimes irritating.
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8 of 18 people found the following review helpful
5.0 out of 5 stars A must for quant 21 Jun 2003
By A Customer
Format:Hardcover
Good reference for the available interest rate model, especially for the pricing of some complex interest rate derivatives. A must for IRD Quants.
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Most Helpful Customer Reviews on Amazon.com (beta)
Amazon.com: 4.7 out of 5 stars  10 reviews
50 of 51 people found the following review helpful
4.0 out of 5 stars Nicely written overview of interest rate models 15 Dec 2001
By Rama CONT - Published on Amazon.com
Format:Hardcover
This recent book, written by two Italian "quants" Mercurio & Brigo, gives a nice and accessible overview of interest rate models which is a compromise between the practitioner viewpoint, expressed for ex. in Rebonato's book "Interet Rate option models"
and the theoretical viewpoint such as the one in Musiela & Rutkowski.
The authors, themselves PhDs in quantitative finance/ applied maths, wrote this book while working as quants in an Italian bank and this first hand contact with the market gave them a
practical view on the subject which markes this book very interesting.
The book contains a "rational" catalogue of models used in practice ( as opposed to models which are impossible to implement!).
In contrast with academic books on interest rate modeling which deal with HJM formulation, there is a lot of emphasis here on LIBOR and Swap market models
(BGM -Jamshidian models) which reflects the current market practice. This is a positive point since there are not many books with details on implementing and using these "market models".
Part II: Interest rate models in practice is particularly useful because it deals with implementation and calibration which, as any practitioner knows, are important and usually delicate issues.
However calibration issues are dealt with somewhat lightly, especially recent developments on modeling cap/swaption smiles
are not included here.
This book can also be used for a graduate level/PhD course on interest rate models.
There are a lot of numerical examples in the book and mathematics is kept to the necessary level while keeping the
approach both rigorous and understandable.

Overall, it is one of the best books written on the subject.
I highly recommend it to PhD students, quants and researchers interested in this field.
40 of 42 people found the following review helpful
5.0 out of 5 stars New stuff and nice overview: hard to beat! 16 Jan 2002
By A Customer - Published on Amazon.com
Format:Hardcover
In the late nineties I went through Brigo's innovative work on stochastic nonlinear filtering with differential geometry techniques. I was favorably impressed by results and style, particularly in his dissertation and in his 'geometry in present day science' very readable overview. Interesting results are found and nicely told with accurate - but not pointlessly complicated - advanced mathematics for the problems at hand, I reasoned.
I've followed a similar path from control to finance, and having worked with interest rate models, I couldn't help but order this Brigo-Mercurio book. I had high expectations 'cause these two guys are working in a bank on the real thing.

Sure enough I'm not disappointed.
1-factor models are handled with great care, a ton of formulas and recipes are given. I've never seen this kind of analysis of pricing with Gaussian 1-f models. The new upgrade of the CIR model is interesting and accurate. "CIR++" is now my favorite 1-f model. I like the treatment of lognormal 1-f models and the explanation of Monte Carlo and trees -- the flow-chart for Bermudan swaptions is crystal clear! Plots of market implied structures and volatility calibration are useful additions.
The chapter on 2-f extensions has one of the best discussions on volatility, and two tons of useful formulas/recipes. Two dimensional trees!
The HJM chapter size is OK. I agree - the useful models embedded in HJM are short rate models and market models.
Market models - these three chapters alone are worth the book. You'll find yourself nodding as you read the guided tour. They make it look easy all the time. The exposition is focused, clear, intuitive, detailed. There's also new stuff, just check the calibration discussion! Smile modeling begins with a brilliant tour and ends with Brigo-Mercurio's new approach - the mixing dynamics - deserving a whole chapter if expanded.
The detailed explanation on products is a much welcome original addition. Cross currency derivatives!
Quotes - as in Brigo's old work - are a pleasant diversion while reading. The 500 and more pages are a treat given the competitive price.
Still there's room for improvements - more "CIR2++"! Something on 3-f models. Historical estimation of the correlation matrix and low-rank optimized approximations. Expand smile modeling! More hedging. Something on structured products. Cross currency libor model. chapter 9 - other interest rate models - sounds out of place and can be suppressed for other things.
This book rings true and has useful teachings for students, academics and practitioners. Although it requires some background in stochastic calculus, it's hard to beat on the pricing front. Kudos to Brigo and Mercurio! It only harms there aren't enough books like this.
24 of 25 people found the following review helpful
5.0 out of 5 stars Definitely a must for quants and financial engineer !!! 11 Sep 2001
By razafindrakoto jean-claude - Published on Amazon.com
Format:Hardcover
Though not precisely at beginner level, it is one of the best financial mathematics book combining rigourous theory with actual practice. I use this book as a reference book in combination with Kennedy and Hunt (Financial Derivatives), with Wilmott's Derivatives. Brigo and Mercurio's book gives an accurate account of the latest research on interest rate derivatives. They provide very good information (theory and practice) on calibration to cap/floor, swaptions data. A "must buy it immediately" book for quants and financial engineers, and also for graduates in quantitative finance. Could be recommended to newcomers in the area of mathematical finance, interested in knowing how mathematics is applied to concrete financial problems.
14 of 15 people found the following review helpful
5.0 out of 5 stars Well written and useful book 4 Nov 2001
By A Customer - Published on Amazon.com
Format:Hardcover|Verified Purchase
In my humble opinion, this is the best book on Interest Rate modeling out there. The writing style is clear and focused and the appendices are fantastic. The book is rigorous but someone with some background in Stochastic Calculus will find it easy to follow. If you need refresher, dont worry the authors have you covered, see the appendix on Stochastic Calculus. Not an introductory book. Very exciting book.
14 of 16 people found the following review helpful
5.0 out of 5 stars The best book I have read on the subject 6 May 2002
By A Customer - Published on Amazon.com
Format:Hardcover
With all the due respect to the other authors I would say that if one is interested in a good theoretical book whihc is also good on the implementation side then the book of Brigo and Mercurion is definetly the best book I have ever read on the subject.
Anyone interested in implementing the LMM/BGM/MSS model in practice is well advised to read it.
I would just say that this is certainly a must have in the field.
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